Remember back in 2011 when Mitt Romney challenged Rick Perry to a $10,000 bet (on his healthcare record) in a presidential primary debate? Well, if tossing around $10,000 makes you look a bit out of touch, Warren Buffett is in another stratosphere.
In 2008, the “Oracle from Omaha” bet a New York hedge fund $1 million that his simple, low-cost investing strategy would outperform the hedge fund industry over 10 years. And he’s winning.
Remind me who Warren Buffett is…
He’s a Nebraska-based investor with a famously frugal lifestyle and a net worth in the billions.
He’s also well known for his accessible investing advice: Buffett believes most money-management companies can’t outperform the market by picking stocks. And even if they do, the high fees will wipe out any extra returns. That’s why he tells non-pro investors to buy passively run index funds, low-fee funds that track a market index.
In the bet, Buffett picked a Vanguard fund that tracks the S&P 500, while Protégé Partners, a firm that puts clients’ money into funds made up of hedge funds, took the other side of the bet with five of its funds.
Wait, what’s a hedge fund again?
For decades, investors with millions to invest—from the very wealthy to pension fund managers—have been dabbling in hedge funds, hoping that the high-paid talent and secretive strategies will deliver outsized returns, even during downturns. The term “hedge fund” comes from the idea of hedging against the risk of losing money, or using investment strategies that can make money in any economic environment.
Today, how hedge funds get paid is as much of what defines them as their investing strategies. Hedge funds take an automatic fee—usually 2 percent of the money under management—and a portion of any profits (typically, 20 percent). Those fees are astronomical compared to Buffett’s index fund’s .05 percent expense ratio. So the hedge fund’s performance has to be very, very good to compensate.
How’s the bet going so far?
Although it won’t end until the last day of 2017, it’s not looking good for the hedge fund. Last year, Buffett announced the index fund was beating the hedge funds by nearly 44 percentage points. The latest available numbers show the index fund is up 65.7 percent after fees, compared with Protégé’s 21.9 percent.
And that’s over a period that included a major financial crisis, which could be expected to favor the hedge fund. Protégé did lose less in the crisis (24 vs. Buffett’s 37 percent), and it took Buffett’s investment four years to make up the ground and pull ahead. But the index fund is now well in the lead.
What does all this have to do with me?
Well, Buffett’s not giving us a piece of his winnings or anything; it’s going to charity. But his bet does underscore a powerful investing lesson we can all benefit from: You might get lucky every once in a while trying to time the market, but over time, it often doesn’t even work for the pros. What works? As Buffett himself would tell you, investing in a mix of low-cost funds with the aim of building wealth over time—and patience.
February 13, 2017